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Market Underpinnings Still Look Encouraging

The stock market in 2018 certainly looks different than it did in 2017. Whereas last year was smooth and upward sloping, this year is, at least so far, volatile and directionless. However, if we just lift up the market’s hood just for a moment we will see plenty to keep the faithful engaged.

Fundamental analysis has all sorts of ratios to measure the health of a particular stock or the market as a whole. Price/earnings, return on investment, debt to equity, price to book, and the list goes on and on. It’s a regular alphabet soup of things to calculate.

Not to be left out of the fun, technical analysis has plenty of ratios of its own. The difference is that all of them depend on data gathered from the market and from participants in the market. None of them are estimated in the way an analyst can put a few inputs of his or her own choosing into a formula, also of his or her own choosing, and spit out what a company might earn next year.

Some might call that guessing. It’s guessing done by very smart people using very sophisticated tools but it attempts to predict the future. And they call chartists fortune tellers.

The Offense/Defense Index

One of my favorite “indicators,” and I write that in quotes, is what I call the offense/defense ratio. Full disclosure, I got the basics from a chart guy named Boris Simonder, many, many years ago. However, since I did not have the data he had, I substituted SPDR sector ETFs to arrive at similar conclusions.

Basically, it is a ratio of offensive, or aggressive, sectors to defensive sectors. Team offense is technology and consumer discretionary, represented by XLK and XLY, respectively. These are generally cyclical in nature. Companies invest in tech when they see improving returns a few months down the road and consumers buy stuff (substitute unsavory synonym here) when they feel flush.

Team defense is consumer staples and health care, represented by XLP and XLV. Both tend to have more stable business models because people buy food, cigarettes and drugs when they need them no matter how many times the Fed jacks up rates.